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Mathematically speaking, free cash flow is net income plus depreciation minus the total of dividends, capital expenditures, required debt repayments, and any other scheduled cash outlays. It’s basically a measure of how much hard cash a company generated in a given period after paying for its regular business expenses and growth initiatives. It is a good gauge of how well management is performing for its shareholders.

Some investors prefer free cash flow over earnings because they believe that earnings, which are largely an accounting figure, can be manipulated more easily than hard cash. Also, in some cases, earnings get distorted unintentionally by accounting principles. Depreciation is an excellent example of the latter situation, as depreciation inherently represents money that has already been spent and has little to no impact on a company’s cash flow, but often has a major impact on earnings.

Of course, free cash flow isn’t the only metric one should consider when evaluating an investment opportunity, but it can quickly weed out companies that simply don’t measure up. To help investors find companies that have a solid history of generating healthy amounts of free cash flow, Value Line produces a weekly screen that appears in the Index section of every issue of The Value Line Investment Survey that highlights this metric.

Labeled “Biggest ‘Free Flow’ Cash Generators”, the screen lists the top 100 companies of the 1,700 The Value Line Investment Survey follows based on free cash flow generation over a trailing five-year period. The long time frame is used to ensure that companies with solid histories of creating cash flow are brought to the fore, weeding out companies that have temporary boosts to their cash flow generation because of short-term or one-time events. For this screen, we have chosen to focus only on companies in the technology space that made the Biggest “Free Flow” Cash Generators list. Of the 25 in that group (see below), we have chosen to highlight Teradata Corporation (TDC).

Teradata Corporation

Teradata is a leader in analytic data solutions, including integrated data warehousing, “big data” analytics, and business applications. The company offers software, hardware, and related consulting and support services to help large organizations compile data about customers, financials, operations, etc. into a single data warehouse. Its analytic technologies then transform said data into information that helps customers manage, integrate, and analyze growing data volumes in order to gain business insight and competitive advantages. The company makes around half of its revenues from products and half from services, and the vast majority of the total comes from existing customers.

Although visibility into near-term demand is not particularly clear at the moment and will likely be driven by the broader economy, we think long-term growth will stem from strength in TDC's Unified Data Architecture bundle of technologies. The package combines a traditional enterprise data warehouse for customer transaction, profile, and product information; Teradata Aster to analyze and discover patterns in “Big Data”; as well as Hadoop-based tech for loading, storing and refining data and optimizing storage costs (more below). Sales related to the latter two products have grown nearly fourfold since 2012, and are expected to generate $100 million in 2014.

While some investors have voiced concern that Hadoop may cut into Teradata’s ETL (extract, transform, load) business, but we think the technology actually offers an opportunity for growth. Hadoop is an open-source framework used for storing and large-scale processing of data sets. Hadoop works well at quickly finding patterns or correlations in large unstructured data and building structured data for a data warehouse. That said, data warehouses exist to collect well-defined data on a regular basis and support the analysis of that data. This is a task in which Hadoop does not excel, since the ending data structure after processing is not fixed. So while Hadoop will take some processing away from ETL, it is also complementary to the information stored in data warehouses. Overall, we think that the company’s estimate that 4%-8% of total workloads could move to a Hadoop environment seems reasonable.

At present, Teradata’s major customers continue to build upon their existing infrastructure. Recently the company commented that discussions with its top 50 customers were slightly more positive than last year. There has also been some increased spending at some of the company’s smaller accounts and it appears to be gaining some business from new customers. With Teradata facing relatively easy comparisons in 2014, we think its year-over-year revenue growth target of 3%-7% (excluding foreign currency translation) seems reasonable.

Companies continue to generate more and more data and they require more in-depth knowledge of this information for managing and improving the performance of the organization. Teradata has a strong grip on this market and we are not overly concerned with the threat of overlapping technologies. Further, the company currently has a reasonable valuation of 20x our forward earnings estimate.

 

Company Name Ticker Industry Name
ANSYS, Inc. ANSS Computer Software
Autodesk, Inc. ADSK Computer Software
MICROS Systems MCRS Computer Software
Oracle Corp. ORCL Computer Software
PTC Inc. PTC Computer Software
Synopsys, Inc. SNPS Computer Software
Teradata Corp. TDC Computer Software
ScanSource SCSC Computers/Peripherals
Tech Data TECD Computers/Peripherals
Check Point Software CHKP E-Commerce
TIBCO Software TIBX E-Commerce
3D Systems DDD Electronics
Anixter Int'l AXE Electronics
Cubic Corp. CUB Electronics
Rovi Corp. ROVI Entertainment Tech
Netflix, Inc. NFLX Internet
priceline.com PCLN Internet
CEVA, Inc. CEVA Semiconductor
PMC-Sierra PMCS Semiconductor
Black Box BBOX Telecom. Equipment
F5 Networks FFIV Telecom. Equipment
Marvell Technology MRVL Telecom. Equipment
NETGEAR NTGR Telecom. Equipment
Synaptics SYNA Telecom. Equipment
Verifone Systems PAY Telecom. Equipment

At the time of this article's writing, the author did not have positions in any of the companies mentioned.